What are Smart Contracts?

Smart contracts are digital contracts devised through software code built on blockchain technology; due to the advancement of technology we are entering a new era in regards to the legality of technologically binding documentation. Many have heard the term ‘smart contracts’ but what constitutes a smart contract and what are the core characteristics that all smart contracts have in common?

How Do Smart Contracts work?

In a nutshell, Nick Szabi invented the notion of the smart contract. When money is paid, it triggers a set of actions as a reaction to the payment.  Nick Szabi provided the example of a drinks vending machine; when money is inserted in to the machine, a transaction is set into a motion, resulting in a transaction that cannot be reversed as the terms are programmed into the vending machine.

What are the Characteristics of Smart Contracts?

According to Nick Szabi, a renowned computer scientist and legal scholar, a smart contract is “a set of promises, specified in digital form, including protocols within which the parties perform on theses promises.”  What’s more, all smart contracts possess four similar characteristics. Firstly, smart contracts are always digital; unlike the traditional contract, smart contracts are always in digital form, written in code and operate as a running program. Secondly, contractual terms are embedded into the smart contact’s software as a matter of course. Thirdly, the transaction is initiated and carried out via a technological process, meaning that the release of payments and other contractual actions are enabled through automation via the software’s rule-based operations. And lastly, smart contacts are irrevocable; once initiated the contractual terms cannot be stopped or reversed.

Apart from the practical technological characteristics of smart contracts, just like traditional contracts, smart contracts need to possess clear and concise wording in order to cater for the purpose they are being used for.

What are the Benefits of Smart Contracts?

Smart contracts possess an array of benefits including:

  • Smart contracts set invariable and transparent contractual terms via blockchain technology, hence increasing the level of trust between the parties.
  • Smart contracts provide trust between parties as smart contracts cannot be executed without the parties of the contract fulfilling their contractual obligations.
  • Smart contracts do not require the participation of intermediaries allowing for direct collaboration between the contractual parties.
  • Smart contracts significantly lower the costs involved to enter into a particular contract enabling trade and exchanges.

Legally Binding Aspects of a Smart Contract 

With regard to the legal aspect and binding effects of smart contracts, it should be noted that just because it is called a contract, it does not mean that such contract is automatically legally binding.  There are a number of variables dependent upon which a smart contract would be legally binding.  Moreover, many jurisdictional issues may arise with a smart contract, since a smart contract is executed in multiple locations through blockchain and any issues that arise with the execution thereof, would prove impossible to know in which country the error occurred and hence which jurisdiction applies.  Enforceability should also be considered, since the technology based on which a smart contract is created, may sometimes give rise to problems to legally enforce such contract.   Therefore, it would be appropriate to insert a dispute resolution mechanism in your smart contract specifically addressing jurisdictional and enforceability variations.

The content of this article is for guidance purposes only.  For advice regarding a specific project you may contact us at info@dplawcyprus.com 

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